The gross domestic product data is released by the BEA on a quarterly basis. The markets eagerly appreciate this data, since it can define the actual beginning or end of a recession, or recovery. It is also useful as a good snapshot of economic activity in the U.S. during the three-month period covered. Some of the information contained in it is forward-looking to an extent. For instance, the fixed investment, and inventory data can provide valuable insight into firms’ confidence, and expansion plans, and by extension hiring intentions. The personal disposable income value can be very useful for gauging the prospects of future consumption, which has widespread implications for all sectors of the economy. The other parts of the release, however, while informational and powerful, lack predictive power to a large extent, and are not coupled to a strong market reaction, especially in the absence of a strong headline surprise.
How it is calculated?
The GDP data calculates the dollar-value of all the finished goods produced within the borders of a nation. It does not include the value of products produced by U.S. firms, or workers overseas, but it does add the value of goods produced by foreign entities within the borders of the U.S. For example, if a German firm establishes a car factory, with German engineers and workers, near Detroit, the cars produced there will be included in the calculation of the GDP numbers, however, if an American firm, wholly owned by U.S. citizens with American workers were to operate a factory in Brazil, the products created there will not be included in the GDP release of the BEA.
Although the BEA’s report appears very complicated at first sight, it in fact depends on a very simple formula that one will encounter in a basic economics textbook.
Gross GDP = C + I + G + (X − M)
I = Investment
G = Government spending
M = imports
Let’s discuss formula in greater detail before examining the BEA report in its light. As we explained, the GDP release merely aims to calculate the value of all final goods and services produced in a nation (in our case, the United States). One way of doing is calculating the total expenditures of U.S. residents on all final goods and services, and then subtracting all foreign-sourced goods and services from that value to reach the value of products produced inside the country, while adding exports. Goods and services utilized in an economy can have only three purposes: immediate use, or consumption (+C), investment for future exploitation (+I), or government spending (+G). Some of the goods and services used for these three purposes are bought from outside the U.S., and they must be subtracted from the equation (-I). In addition to these items, there are goods that are produced inside the country for use outside (exports), but since they are produced by economic activity in the U.S., they must also be included in the GDP value (+X).
Putting these values together we reach at the equation.
Gross GDP = C + I + G + (X − M)
The C (consumption) item corresponds to real personal consumption expenditures, the I(investment) item is broken down to real non-residential fixed investment, real residential fixed investment, and real private inventories, the G (government expenditures) item corresponds to real federal and state government consumption expenditures and gross investment items in the BEA release.
The Gross domestic product is composed of a number of items each of which provides information on a different aspect of the American economy. Let’s examine them here item by item..
Price Index for Gross Domestic Purchases
This index is created from the personal consumption expenditures index, the gross private domestic investment index, and the government consumption, expenditures, and gross investment indexes. The index captures changes in prices paid by U.S. resident firms and consumers for finished goods, including consumption, investment, and expenditures. It differs from the GDP deflator because it does not include the prices of exported goods and services, and includes the price changes in imports.
This item is a combination of some aspects of the CPI and the PPI. Although like the CPI, it does include import prices, it does not use a basket, and cannot be thought of as a measure of price changes experienced by consumers.
Real Personal Consumption Expenditures
This item measures the real value of goods and services purchased by individuals in the U.S. The data provided in this count is used by the Federal Reserve in the calculation of the “Chain-type Price Index for Personal Consumption Expenditures”, or as it is commonly known, the PCE.
The item is broken down into two parts. The durables section measures the expenditures of consumers durable items such as computers, chairs, mobile phones, and others. The non-durables section measures expenditures in food products, cosmetics, pharmacy products, and similar items that are depleted through use.
This item is one of the more closely watched pieces of information in the GDP release, since it provides valuable insight with respect to the spending behavior of U.S. citizens. It is more reliable than the retail sales data, and covers a greater segment of the economy, as it also includes services expenditures. Its disadvantage is the lack of detail, and the possibility of revisions. Since the Federal Reserve also pays a lot of attention to this value, market reaction can strong and unpredictable to surprising releases.
Real Non-residential Fixed Investment
Fixed investment is a term used to define spending on fixed capital, such as means of production (machinery, equipment, etc), and residential buildings. It also includes the replacement cost of depreciating goods.
Real non-residential fixed investment is broken down into two counts of non-residential structures which defines factories, restaurants and similar buildings, and equipment and software, which includes hardware and software, along with various items of machinery.
This item is especially important for understanding future productivity growth, the optimism of businesses, and the growth potential of the economy. As firms invest in capital goods, they are showing their confidence that the national economy will justify the investments made today by creating enough demand for the goods and services created later through capital expenditures. This confidence will naturally translate to employment and growth over the medium and longer terms, providing great benefits to economic dynamism and strength of a nation. Also, capital expenditures are aimed at increasing productivity at firms. As firms spend on better communications equipment, and improve the efficiency of production with more advanced technologies, they are able to deliver greater value in the same product for a higher or similar price, or create new products all of which lead to healthy long-term growth for the economy.
Real Residential Fixed Investment:
This item states the inflation adjusted dollar-value of investment in residential structures like homes, apartments, condominiums, and related items.
Real Exports and Import of Goods
The BEA release also includes information on the growth of real import or export of goods in the U.S. It is important to remember that the goods mentioned are only finished goods, and do not include intermediate products, such as car parts. The difference between exports and imports is added to investment and expenditures to calculate real GDP.
Real Federal Government Expenditures and Gross Investment
This item measures the contribution of the federal government’s various expenditures including consumption and investment to the overall GDP number. It is broken down to the national defense, and non-defense items. The national defense item includes such things as the construction of bases, the equipment and weapons produced for military personal, and the cost of such expenditures like modernization or improvement of existing items. The non-defense item calculates the cost of investment and consumption for ordinary government functions such as the maintenance of federal schools, or prisons.
Real state and local government consumption expenditures and gross investment
This item measures the cost of goods and services used by state governments for the local government purposes. This and the previous items are usually subtracted from the actual GDP numbers and the growth rate in order to reach at a purer picture of private sector activity and demand. Since the governments actions can be dependent on factors other than supply and demand, and also because political concerns can sometime lead to untimely, and wasteful expenditures, it is a good idea to subtract this item from the overall GDP number in order to reach at a better picture of underlying economic dynamism.
Real Final Sales of Domestic Product
This count simply subtracts inventories from the overall GDP number. The purpose is seeing the amount of production that was created for the sole purpose of existing demand. In other words, the growth in this item is a reflection of the growth in total demand for U.S. products, including government and export demand as well.
This number reflects the demand situation as it exists, without taking into account the opinions and expectations of corporations and managers. As such it is a good indicator of actual economic vigor, although it has little predictive value.
Real Gross Domestic Purchases
This is the data used for the calculation of the gross domestic purchases price index. This item contrasts with the previous one since it reflects total U.S. demand for goods and services. In the previous item, we had examined the total demand for U.S. goods and services both inside and outside the country. In this item the BEA measures total U.S. demand for all types of goods and services whether they are produced inside or outside the country.
As with the previous piece of data, real gross domestic purchases data includes investment and consumption demand at both the private and public sector.
Current-dollar Personal Income
This item tells us the change in personal income of U.S. residents in present day dollar values.
Personal Current Taxes
This item states the total personal taxes paid by U.S. residents.
Disposable Personal Income
Disposable personal income is simply the current-dollar personal income minus personal current taxes. It is the income earned by U.S. residents which can be spent.
It is clear that the GDP release contains a lot of extremely useful analytical information which can be utilized by traders, analysts and economists for understanding present conditions, and creating scenarios for the future. The data is backward looking, but since economic events move so slowly, economic dynamics established a quarter before now will lead to outcomes that will be valid even after the passage of years. This nature of economic events ensures that such a comprehensive package of data such as the GDP release will always pack a powerful punch in spite of its lagged nature.
The GDP data usually leads to a lot of volatility before its eventual release, but unless there is a powerful surprise, the early commotion does not lead to new trends in the short term. In the long run, however, the implications derived from the data, especially for interest rates, and employment, can be crucial for currency prices, and long term price action. Just like the non-farm payrolls release, or the FOMC’s interest rate decisions, the GDP data can create new momentum, or accelerate existing movements in the price action in the long-term, without short term traders anticipating it.